Morgan Stanley Seeks $10 Million From Convicted Ex-Trader

Joseph F. “Chip” Skowron III, a former hedge fund manager at Morgan Stanley’s FrontPoint Partners LLC, is serving five years in prison for insider trading. Morgan Stanley lawyers are in court in a bid to recover $10.2 million. Photographer: John Marshall Mantel/Zuma Press

Jan. 14 (Bloomberg) -- Insider traders like Joseph F.
“Chip” Skowron III must be held responsible for the harm they
cause their employers, Morgan Stanley lawyers told an appeals
court in a bid to recover $10.2 million.

Skowron, 43, who is serving five years in prison, was a
hedge fund manager at Morgan Stanley’s FrontPoint Partners LLC
until he was charged in April 2011 with using inside information
to avoid $30 million in losses.

The U.S. Court of Appeals in Manhattan heard arguments
today in Skowron’s appeal of a judge’s order that he pay
$10.2 million in restitution to the New York-based bank, which
closed FrontPoint after the scandal. Morgan Stanley and
prosecutors argued in support of the judge’s order, saying he
hid his activities from his employer and the government.

“There isn’t any doubt, had he not lied, he would have
been fired immediately,” Kevin Marino, a lawyer for Morgan
Stanley, told the court today. “And that was before he was paid
$20 million.”

The bank has also sued Skowron for $65 million, part of
what his spokesman Montieth Illingworth previously called an
effort to “grind down what remains of Dr. Skowron’s life.”

File Lawsuit

Joshua Epstein, Skowron’s lawyer, told the appeals panel
today that Morgan Stanley is entitled to file a lawsuit to seek
the money it paid his client. The firm isn’t entitled to
restitution in the criminal case, he said.

With U.S. prosecutors pursuing insider trading on Wall
Street, banks and hedge funds will probably be watching the
outcome of the case, said A. Jeff Ifrah, co-author of “Federal
Sentencing for Business Crimes.”

“The reputation of an employer like this one can get
killed by the conduct of its employee,” Ifrah said in a
telephone interview.

Seeking restitution “is certainly a good strategy” to
reclaim a company’s good name, said Ifrah, a Washington lawyer
not involved in the case.

Today’s argument comes as Skowron, a doctor who trained at
Harvard and Yale, completes his first year at the U.S. prison
camp in Minersville, Pennsylvania.

On Aug. 5, 2011, he pleaded guilty to conspiracy to commit
securities fraud and obstruct justice. He admitted helping
FrontPoint avoid more than $30 million in trading losses on
Human Genome Sciences Inc., a Rockville, Maryland,
pharmaceutical firm that was acquired by GlaxoSmithKline Plc.

Secret Tips

Skowron admitted that he got secret tips from a French
physician, Yves Benhamou, who was helping to oversee a clinical
trial of an HGSI hepatitis drug, Albuferon. After Benhamou told
Skowron about disappointing results in the drug trial, Skowron
sold HGSI shares in FrontPoint’s health-care funds.

At his sentencing in 2011, U.S. District Judge Denise Cote
ordered Skowron to forfeit $5 million. She also required him to
pay restitution of $5.9 million to five investors that bought
FrontPoint’s HGSI stock in block trades just before HGSI
announced the clinical-trial results in January 2008. Deutsche
Bank AG and Galleon Group LLC were among the funds.

At the time of his sentencing, Skowron had a net worth of
$22 million.

On March 20, the judge ordered Skowron to pay restitution
of $3.8 million to a sixth victim, Morgan Stanley, for the
bank’s legal fees and $6.4 million to cover one-fifth of his
compensation from 2007 to 2010.

Bank’s Expectation

Morgan Stanley’s “expectation was that Skowron would abide
by policies” that “prohibited insider trading,” Cote wrote in
an opinion.

“His crimes deprived Morgan Stanley of the honest services
of its employee, diverted valuable corporate time and energy in
the defense of Skowron and FrontPoint and injured Morgan
Stanley’s reputation,” she wrote.

The judge refused to award Morgan Stanley $33 million from
Skowron that the bank paid to settle a related U.S. Securities
and Exchange Commission lawsuit. The money was illegal profit,
not funds FrontPoint was entitled to, Cote said.

In his appeal, Skowron advanced largely technical arguments
for why Cote’s order violated the U.S. Mandatory Victims
Restitution Act, which provides for repayment to “an
identifiable victim” of a fraud.

For instance, he didn’t commit “honest services fraud”
because he didn’t “accept a bribe or kickback from a third
party,” as the law requires, he said.

‘Entirely Speculative’

He also argued there’s no proof that his compensation
stemmed from the illegal trades. “This is entirely
speculative,” Epstein wrote.

The U.S. Supreme Court in 2010 narrowed the scope of the
U.S. restitution law, Ifrah said. Illingworth, Skowron’s
spokesman, declined to comment on the appeal.

Prosecutors defend Cote’s decision, pointing to cases in
which offenders were ordered to surrender part of their pay. In
one, a police chief who took bribes from mobsters running a
gambling business was ordered to pay an amount equal to about
25 percent of his salary.

Prosecutors say Skowron’s pay was tied to his funds’
performance.

“Skowron avoided approximately $1.36 million in losses to
his own compensation by causing FrontPoint to avoid the
$30 million loss,” they wrote.

By hiding the fraud from internal Morgan Stanley
investigators beginning in early 2008, Skowron “profited by
keeping the job that he certainly would have lost,” they said.

‘Clear Choice’

“He has a very clear choice in front of him,” Assistant
U.S. Attorney David Massey told the court today, arguing that
the amount Skowron was paid after he obstructed the government’s
investigation was properly subject to return to Morgan Stanley.
“If he tells the truth, he’ll be fired within the hour.”

Jerika Richardson, a spokeswoman for U.S. Attorney Preet
Bharara, declined to comment on the case.

News of the fraud in November 2010 led Morgan Stanley to
write down $116 million of the value of its FrontPoint
investment and, after “massive redemptions,” to shutter
FrontPoint’s health-care funds, which managed $1.55 billion,
prosecutors said. The bank says it’s a victim.

“The significant compensation Morgan Stanley paid to
Skowron was undeniably based in part on the success of his
criminal scheme to commit insider trading and then conceal that
crime from Morgan Stanley and the government,” the bank’s
lawyers wrote.

Jim Wiggins, a Morgan Stanley spokesman, declined to
comment on the appeal.

Bank Sues

On Oct. 31, Morgan Stanley sued, seeking the $33 million
Cote said it was not entitled to, as well as the entire
$32 million it paid Skowron from 2007 to 2010.

The bank called Skowron a “faithless servant” who lied
repeatedly to continue being paid by the bank and to avoid the
blow to his reputation that a loss on HGSI would have caused.
Skowron hasn’t responded yet.

Since August 2009, Bharara’s office has brought insider-trading charges against 76 people, many at Wall Street funds.

They and other employers, whose insurance carriers may
require them to sue rogue employees, need to be certain they
can’t be tarnished by wrongdoing before pursuing restitution,
Ifrah said.

“You have to make sure you’re solid on noninvolvement
before you throw yourself into the lion’s den,” he said. “Do
you want to really get involved in a criminal proceeding? Are
you confident and comfortable enough?”

The case is U.S. v. Skowron, 12-1284, U.S. Court of Appeals
for the Second Circuit (Manhattan). Morgan Stanley’s suit is
Morgan Stanley v. Skowron, 12-cv-8016, U.S. District Court,
Southern District of New York (Manhattan).